Stock plunge rattles nerves — but don’t hit the bottle just yet

NEW YORK, NY - AUGUST 21: A trader works on the floor of the New York Stock Exchange (NYSE) on August 21, 2015 in New York City. The Dow fell over 500 points in trading today as global markets continue to react to economic events in China. (Photo by Spencer Platt/Getty Images)

Photo: Spencer Platt, Getty Images

If the stock market rout felt especially painful last week, it’s only because it’s been so long since we had one.

The Dow Jones industrial average suffered its worst one-week sell-off since 2008, officially entering correction territory with a 10 percent drop from its May 19 peak.

The Nasdaq narrowly avoided a correction, closing down 9.8 percent from its July 20 high. The Standard & Poor’s 500 index is down 7.5 percent from its May 2 high.

Experts say sell-offs are normal, even good if they don’t get carried away.

“They are healthy, they wash out excess,” said Karl Mills, president of Jurika, Mills & Keifer Investment Advisors. “It’s not time to take up drinking or anything.”

Since 1946, the S&P 500 has dropped 5 to 10 percent 60 times, or almost once a year, according to S&P Capital IQ.

“When you are in them, it always feels like it’s going to be worse,” Mills said.

Traders had a rough day on the floor of the New York Stock Exchange. The Dow fell more than 500 points as global markets continue to react to economic events in China.

Photo: Spencer Platt, Getty Images

And sometimes, it is. In the postwar period, there have been 19 corrections of 10 to 20 percent. The average one lasted five months and took 14 percent off the index, which recovered its losses in four months.

Mega-meltdowns like in 2007-09, which chopped the S&P 500 by 57 percent, are rare. There have been only three since 1946, but on average the index declined 51 percent and took almost five years to recover.

Long overdue

The market was long overdue for a correction. “We have gone 47 months without a decline of 10 percent or more,” said Sam Stovall, U.S. equity strategist with S&P Capital IQ.

Trader Dermott Clancy watches Friday’s chaos at the New York Stock Exchange, where investors had a rough week.

Photo: Richard Drew, Associated Press

Most analysts trace the recent sell-off to doings in China. Its economic growth rate has slowed from 11.5 percent in 2011 to 7.4 percent last year. Stovall is expecting a 6.8 percent increase this year and 6.6 percent next.

That has raised concerns about countries and U.S. multinationals that sell to China.

One thing hurting China is its currency, which is closely linked to the U.S. dollar. The dollar’s strength over the past year has made it harder for both U.S. and Chinese exporters to compete in world markets.

Two weeks ago, the Chinese government took steps that reduced the value of its currency. Since then it’s down about 3 percent against the dollar. That should make Chinese exports a little cheaper and imports into China a little more expensive.

The move had pros and cons. For U.S. companies that sell to China, “that means less demand. For companies that buy things from China, it’s good; they can get them cheaper,” Mills said. For China’s export-driven economy, it’s a positive because their goods are relatively more competitive — “which is good if you are worried about China slowing down.”

The devaluation was more important for China than the United States, because it’s far more dependent on exports.

Stock plunge rattles nerves — but don’t hit the...

1of2Specialist Mario Picone, right, watches the numbers as he works on the floor of the New York Stock Exchange, Friday, Aug. 21, 2015. The Dow Jones industrial average has plunged more than 530 points and is in a correction amid a global sell-off sparked by fears about China's slowing economy. Oil tumbled below $40 per barrel for the first time since the financial crisis. (AP Photo/Richard Drew)Photo: Richard Drew, Associated Press

2of2NEW YORK, NY - AUGUST 21: A trader works on the floor of the New York Stock Exchange (NYSE) on August 21, 2015 in New York City. The Dow fell over 500 points in trading today as global markets continue to react to economic events in China. (Photo by Spencer Platt/Getty Images)Photo: Spencer Platt, Getty Images

Robert Johnson, Morningstar’s director of economic analysis, said China makes up only 0.9 percent of the U.S. gross domestic product, and a lot of that is exports of Boeing jetliners and foods — deals that won’t evaporate quickly. Nevertheless, investors used the devaluation of the yuan to sell stocks, or at least take the blame for the U.S. stock sell-off.

Rough Friday

The selling intensified Friday after China released an indicator that showed manufacturing activity fell to a 6½-year low, despite efforts to stimulate the economy.

Along with China, experts are pinning the stock sell-off on plunging oil prices. They have fallen by roughly half since last summer.

At first, most people chalked up the decline in oil prices to increased supply. “Now we are uncovering that it was also a pretty sharp reduction in demand,” Stovall said, suggesting a slowing in the global economy.

In times past, falling oil prices were seen as a positive for consumers and the economy, tantamount to a tax cut. But energy companies are highly capital-intensive and have a lot of fixed costs. When their revenue falls, their cash flows suffer, said Ingrid Baker, manager of the Invesco Emerging Markest Equity Fund. “Oil companies are a decent part of the S&P 500,” she said. Their problems have contributed to the selloff.

Johnson said his biggest worry is something out of left field, such as “some big mining company that borrowed from Citibank can’t repay its loan, or some big hedge fund that bet the wrong way is a JPMorgan customer, or that some some sovereign debt comes up for renewal” and can’t be rolled over. In other words, some type of “shock event” that could have ripple effects throughout the world.

He is especially worried about Brazil, which exports oil and “ships a lot of stuff to China.”

One upside to the sell-off is that it has made stocks a little less overpriced.

PE ratio still high

When the S&P 500 was at its peak in May, it was trading at 22.4 times net earnings for the trailing 12 months. Now it’s at 20.8 times, which is still a 6 percent premium to its median price earnings ratio since 1988 and 30.5 percent above its median since 1936. However, interest and inflation rates are much lower than they have been historically, which should justify a higher PE, Stovall said.

On Friday, the S&P 500 fell below 2,034, which “a lot of technicians said was the last line of resistance,” Stovall said. “It pretty much opened the floodgates to technically driven sell orders. Now we are at the next level of support,” which is 1,970. The index closed a hair above that Friday.

If it drops below 1,970, the next level of support is around 1,920, “the precipice of a 10 percent decline” from the S&P’s closing high of 2,130.

Stovall said he would not be surprised to see a further dip in prices, but he expects them to be higher by year end. “Based on our earnings estimate and inflation expectations, the S&P could close around 2,130 to 2,150,” he said.

Kathleen Pender writes the Net Worth column in The San Francisco Chronicle. She explains how the big business and economic news of the day affect a household's net worth. She covers saving, investing, debt, taxes, housing, mortgages, retirement plans, employment and unemployment with a focus on issues specific to California and the Bay Area.

When it comes to big financial decisions, she believes that the simplest answer is almost always the best and that people would stay out of money trouble if they didn't get involved in things they can't understand. Pender welcomes questions from readers and frequently answers them in her column.

She majored in business journalism at the University of Missouri-Columbia and was a Knight-Bagehot fellow in business journalism at Columbia University.